K-Shaped Recovery: The Dilemma Facing India’s Central Bank
Manufacturing growth in India has been projected at a mere 0.9 percent year-on-year by the Central Statistics Office for the current quarter, after shrinking by 1.1 percent in the December 2022 quarter. However, the Purchasing Managers Index (PMI) for manufacturing has been showing robust growth for several months now, with the Manufacturing PMI for February coming in at 55.3, signifying strong expansion from the previous month.
Divergence between PMI data and GDP numbers
The PMI measures month-on-month expansion, which is different from GDP growth numbers that usually measure year-on-year changes. However, Pollyanna de Lima of S&P Global said that companies were confident in the resiliency of demand and continued to add to their inventories by purchasing additional inputs. This is markedly different from what the estimates for Gross Value Added for manufacturing are telling us. Private consumption growth is projected to be a piffling 1.5 percent for the current quarter, so the question arises: Is the economic recovery running out of steam?
K-shaped recovery
NielsenIQ’s retail sales data show that volume growth declined in all four quarters in 2022, with rural demand being badly affected. The top firms in the PMI surveys may be doing well, but the situation is very different for the masses. The RBI’s consumer confidence survey shows that only 32 percent of those surveyed said they would increase spending on discretionary items in the next one year. No wonder, the Index of Industrial Production shows that production of consumer durables in December 2022 was lower by 10.5 percent from a year ago.
Also Read: The Russia-Ukraine Crisis: Effects on Global Markets and the Road Ahead
What will the Reserve Bank of India (RBI) do?
The question is: What will the Reserve Bank of India (RBI) do? The Monetary Policy Committee (MPC) had raised its GDP growth projections for Q1 and Q2 of FY24 to 7.8 percent and 6.2 percent, respectively, against the earlier forecasts of 7.1 percent and 5.9 percent. However, Gaurav Kapur, chief economist at IndusInd Bank, wrote that external pressures are going to test the economy’s resilience in the coming fiscal year. Will the MPC projections change after the latest GDP numbers, considering that private consumption is so weak?
Core inflation and monetary policy
If demand is weak, how is core inflation remaining elevated? Simply put, firms have been successful in passing on input price increases to their customers. A look at the Q3 corporate results show that manufacturing firms have maintained their operating and net profit margins and have even improved them compared to the preceding quarter. The MPC statement in February this year said, “The ongoing pass-through of input costs to output prices, especially in services, could continue to exert pressures on core inflation.”
The RBI and MPC’s dilemma
This then is the dilemma the RBI and the MPC face: whether to continue to tighten monetary policy in an effort to bring core inflation down, while at the same time higher interest rates slow down growth. It doesn’t help that one big reason for weak consumption is inflation in food prices, over which the central bank has no control. Recall that two members of the MPC voted against a rate hike at the last meeting. On the one hand, there is the view of RBI Deputy Governor Michael Patra that “low and stable inflation is the credible nominal anchor for a reinvigoration of growth”. Set against that is what Jayanth Varma said at the last MPC meet: “In the second half of 2022-23, monetary policy has, in my view, become complacent about growth, and I fervently hope that we do not pay